25. Macroeconomic Aims of the Government

1. Macroeconomic Aims of Government

Governments pursue several key macroeconomic objectives to ensure long-term prosperity and stability in their economies:

a. Economic Growth

• Definition: An increase in the output of goods and services in an economy.

• Actual Growth: Growth resulting from utilizing idle resources.

• Potential Growth: Growth from expanding productive capacity (e.g., new technology, better infrastructure).

• Benefits:

• Higher living standards

• Increased employment

• Higher tax revenues

• Improved healthcare, education, and housing

b. Low Unemployment

• Definition: The condition where people willing and able to work are unable to find jobs.

• Types of Unemployment:

• Frictional: Temporary, between jobs

• Structural: Mismatch between skills and job requirements

• Cyclical: Due to downturns in the business cycle

• Voluntary: Choosing not to work despite opportunities

• Full Employment: Not 0% unemployment—some frictional or voluntary unemployment is always expected.

c. Price Stability (Controlling Inflation)

• Inflation: Sustained rise in the general price level over time.

• Target Rate: Often around 2%, not 0%, due to measurement biases and potential benefits of mild inflation.

• Reasons for Aim:

• Avoids uncertainty in investment and savings

• Maintains international competitiveness

• Prevents panic buying or wage-price spirals

d. Balance of Payments Stability

• Balance of Payments (BOP): Record of all economic transactions between a country and the rest of the world.

• Components:

• Current Account: Trade in goods/services, income, and transfers

• Capital Account: Physical assets (like buildings)

• Financial Account: Investment flows

• Why Stability is Crucial:

• Long-term deficits can cause debt

• Surpluses can mean underconsumption

• Aim for approximate balance over time

e. Redistribution of Income

• Why It Matters:

• Reduces poverty and inequality

• Prevents social unrest

• Ensures equal access to basic needs like healthcare and education

• Tools Used:

• Progressive taxation

• Welfare programs (e.g., housing, unemployment benefits)

• Free or subsidized public services

2. Aggregate Demand (AD) and Shifts

a. Definition: Total demand for goods and services in an economy at a given price level.

• Formula: AD = C + I + G + (X – M)

• C = Consumption

• I = Investment

• G = Government spending

• X – M = Net exports

b. Factors Causing Rightward Shift in AD (Increase)

• Lower interest rates

• Higher consumer/business confidence

• Government stimulus (fiscal policy)

• Improved competitiveness of exports

• Currency depreciation (makes exports cheaper)

c. Factors Causing Leftward Shift in AD (Decrease)

• Higher interest rates

• Increased taxation

• Economic uncertainty

• Fall in global demand

3. Aggregate Supply (AS)

a. Definition: Total quantity of goods and services that firms in the economy are willing and able to supply.

b. Short-Run Aggregate Supply (SRAS)

• Influenced by changes in production costs:

• Wages and employment taxes

• Raw material and commodity prices

• Exchange rates

• Government regulations and business taxes

c. Long-Run Aggregate Supply (LRAS)

• Determined by:

• Technology

• Human capital

• Infrastructure

• Investment in capital goods

4. Policy Conflicts

Economic objectives often conflict, requiring trade-offs:

a. Inflation vs. Unemployment

• Reducing unemployment may increase inflation due to higher wages and spending.

• Controlling inflation (e.g., raising interest rates) may reduce demand and increase unemployment.

b. Economic Growth vs. Balance of Payments

• Higher growth can increase imports (due to higher income) faster than exports, worsening trade balance.

c. Equality vs. Growth

• Redistribution through taxes may reduce incentives for investment and enterprise, potentially lowering growth.

d. Tinbergen’s Rule

• Every macroeconomic goal must have its own dedicated policy tool. Using one tool for multiple goals can be ineffective.

5. Policy Priority

When conflicts arise, governments prioritize aims based on:

• Severity of the issue (e.g., high inflation might be more urgent than moderate unemployment)

• Public opinion

• Time sensitivity (short-term vs. long-term trade-offs)

• Political considerations

For example:

• In a recession, priority may be to reduce unemployment and stimulate growth.

• During inflationary periods, the focus might shift to price stability.